The Treasury yield curve isn't matching the futures market’s view of rate hikes.
Is WIRP out of whack, or are Treasuries tardy? It’s a difficult but crucial question for investors.
The fed funds futures market—the WIRP (World Interest Rate Probabilities) function on the trusty Bloomberg terminal—is showing expectations for a hike at every Federal Reserve meeting this year, including some of the 50 basis-point variety, on the way to 2.25% in December. But yields on U.S. Treasuries have not risen in step. Which curve should investors follow?
The dislocation is partly due to the massive flight-to-quality trade stemming from the Russian invasion of Ukraine. It’s also a function of the cutback in supply due to lower bill issuance by the Treasury Department and the restraints of quarter-end transactions. The imbalance has pushed yields on the front end below even the Fed’s Reverse Repo Facility, set at 30 basis points. Yields of securities with maturities out to one year have sharply steepened, but not steep enough to match policy expectations, especially with inflation ascending its own cliff. The Personal Consumption Expenditures Index hit 6.4% annualized in February, with core PCE (which excludes food and energy prices) rising 5.4%. Both rose from January readings of 6% and 5.2%, respectively, and are multi-decade highs.
But the discrepancy also seems another case of the market trying to lead the Fed. That’s not something policymakers like. The last time it happened was when anticipation had built for a half-percentage-point hike at the March policy meeting. Fed Chair Jerome Powell shot that down by saying he favored a quarter-point rise. He isn’t scheduled to speak or make a public appearance soon, but New York Fed President John Williams and soon-to-be Fed Vice Chair Lael Brainard give speeches in early April. Those and the minutes of the March Federal Open Market Committee meeting, released April 6, should provide insight. Indication that members are closer to reducing the balance sheet would be welcome, as more supply is needed to right-size the yield curve.
In contrast, the tax-free money market is normalizing. It has been fighting the Fed, with issuers able to find funding at lower-than-expected rates. But the SIFMA Municipal Swap Index surged after the March meeting to hit 0.51%, a strong level even before factoring in potential tax benefits. Issuance of short-term commercial paper, asset-backed commercial paper and other prime instruments also has grown, offering attractive rates.
When it comes to finance, many Americans have April 18 and the IRS on their minds. For cash managers, it’s April 11. That’s the deadline for submitting comments to the SEC about its proposal of money market fund reform. Letters from industry participants, including ours, are arriving. The next step will be to wait, and wait, as the agency weighs the responses and makes its ruling.
In light of the uncertainty of the yield curve, we shortened the weighted average maturities (WAM) of our prime and muni money market funds to a target range of 25-35 days, matching that of our government products.